PARIS A month after making his European debut with a drive to mutualise the euro zone's debts via joint bonds, French President Francois Hollande would settle for a pilot scheme of short-term "euro T-bills" for the time being, aides say.
But there is no evidence that the new Socialist French leader's thinking is gaining any traction with German Chancellor Angela Merkel, despite support from the executive European Commission, Italy and Spain.
Paris still believes that in the long term euro bonds would be the best way for the single currency bloc to protect weaker members from being singled out by bond market speculators. For now, France hopes to get an agreement to test the water with short-term paper that might be more acceptable to Berlin.
Hollande will also try to overcome Merkel's opposition to creating some form of debt redemption fund, an idea raised by the German government's council of economic advisers, that would lump together euro zone public debt above 60 percent of gross domestic product and pay it down over two or three decades.
"Euro bonds cannot happen right away. There are mechanisms that are a form of euro bonds which we can put into place much more easily if there is a political will, such as euro bills," a source close to Hollande said. "These would have maturities of around three months and would not require the same guarantees."
The sources said they were hopeful that the small burden represented by such short-term debt could make it acceptable to Berlin, despite Merkel's rejection in principle so far of any mutualisation of euro zone debt.
Germany has repeatedly rejected the idea of jointly issued bonds and has given short shrift to recent proposals for euro bills as well. Foreign Minister Guido Westerwelle said on Monday: "There is no way Germany will consider any shared liability for all the debts in Europe, directly or indirectly."
Common debt issuance would push up borrowing costs for fiscally sound northern bloc countries. Berlin has been able to borrow at negative real interest rates in recent weeks.
A move towards mutualised debt in the long term would probably require Germany to change a constitutional clause barring fiscal transfers to other governments.
"A completely different approach would be to set up a redemption fund to take care of debt above 60 pct of GDP which member states would then reduce by tranche," the source close to Hollande said. "It's something that we are proposing be examined, although the German government is not on board yet."
Hollande, who has inherited a sickly economy with 10 percent unemployment, is winning Berlin round to his plan for Europe to invest 120 billion euros to stimulate growth via project bonds, redeployed structural funds and European Investment Bank loans.
In return, aides say France is ready to discuss a long-term plan sought by Berlin to point Europe towards deeper fiscal and political union, which would involve giving European Union institutions more say over national budgets.
As EU leaders hone their positions ahead of a June 28-29 EU summit, Berlin flatly disagrees with the idea Hollande is championing of a debt redemption fund to relieve the strain of sky-high interest rates on recession-hit countries like Spain.
Hollande discussed the redemption fund idea when he met Germany's Social Democratic opposition leaders for talks in Paris last week and broached it in talks in Rome the next day with Italian Prime Minister Mario Monti.
The French hope that by rowing back on a firm time frame for fully fledged euro bonds, they can win Berlin round on a redemption fund, along with joint euro bills, the source said.
"These are both things we could start to work on without having to wait for a deeper political and fiscal union."
NOT GIVING UP COMPLETELY
Merkel has also rebuffed pressure from Paris for Germany, Europe's largest economy and paymaster, to jointly guarantee bank deposits in the euro zone to avert bank runs.
Hollande may struggle to win her over to the kind of banking union he wants to create in the near future to insure savers' deposits, provide a mechanism to aid ailing banks that avoids hitting states or taxpayers, and harmonise bank supervision.
But Merkel has accepted the principle of European Central Bank supervision for big cross-border banks.
French sources say Paris hopes to reach an accord on first-stage measures by the end of the year, which could be implemented fast and without EU treaty change, to protect savers and states from painful bank bailouts.
It could then agree to leave until later decisions on the thornier issues of which institution should be in charge of integrated supervision and under what legal framework.
France circulated its position in writing last Thursday to European Council President Herman Van Rompuy and EU leaders ahead of a four-way meeting in Rome on Friday between Hollande, Merkel, Monti and Spanish Prime Minister Mariano Rajoy.
The document is grouped into three sections. One covers the 120 billion euro pro-growth package and second-stage measures such as a financial transaction tax that France wants an agreement on by the end of 2012, even if Britain and some others are not on board.
Another section on financial stability details ideas for an integrated bank sector framework and for giving the ESM permanent bailout mechanism the flexibility to recapitalise banks directly without going via governments.
A second source said France believed a mechanism could be found to link such direct ESM lending for troubled banks to a state guarantee, giving it the commitment some fear it would otherwise lack.
The third section outlines the need for a 10-year road map to deeper economic and monetary union, something Hollande has more elbow room to promote at home since his Socialist Party won an outright parliamentary majority on Sunday.
Euro bonds would be part of that long-term plan.
Some economists say issuing euro bills would be of limited value for nations struggling to roll over long-term debt, given their very short maturities, but Paris believes they could be an effective way of testing market sentiment.
Paris has rejected for now a proposal by two senior European economists to issue joint euro zone "blue bonds" for debt up to 60 percent of GDP, leaving governments to issue higher-yield national "red bonds" to fund any borrowing beyond that limit.
A study by the French Treasury found such a scheme could push yields through the roof for red bonds for issuers with debt ratios above 100 percent of GDP. France's own ratio is approaching 90 percent, and Italy's is over 120 percent.
(Additional reporting by Daniel Flynn in Paris and Stephen Brown in Berlin; Editing by Paul Taylor and Hugh Lawson)